British Polythene Industries has become the latest scheme to tackle growing liabilities by switching the pensions-in-payment calculation to the consumer price index from the retail price index.
Where scheme rules allow, trustees are increasingly changing the inflation index used to measure future pension payment increases, a move estimated to reduce the ongoing costs of defined benefit pension schemes by around 1 per cent a year.
Last year a key High Court ruling permitted Arcadia retail group's schemes to switch to CPI from RPI to calculate pension increases and revaluations, with the stipulation that the decision should be made by both the employer and trustees.
BPI agreed the use of CPI for calculation of pensions in payment with scheme trustees last month.
Future funding plans
BPI agreed a future funding rate of £3.6m a year rising in line with CPI, subject to a cap of 5 per cent, following the scheme’s actuarial valuation of April 6 2014.
The company also made provision for three additional one-off payments in 2016-18 of between £0.25m and £1.5m, subject to the group’s profit achieving agreed targets in 2015-17.
This will be in addition to quarterly contributions totalling £1.9m a year in relation to the pension funding partnership, a 20-year property-backed arrangement that has been in place for three years.
Source: BPI
The move was made in conjunction with a one-off payment of £11m, scheduled for June 2015, to increase the security of members’ pensions and to further reduce the deficit – reported to have risen to £99.1m from £57m at the end of 2013, according to the company’s latest annual report.
David Harris, finance director at BPI, said: “Really what this is reflecting is the broader environment around RPI. Relatively it is no longer used as a national statistic – the measure of inflation is CPI.”
The £232.2m BPI scheme closed its defined benefit pension scheme to future accrual in 2010 and currently has slightly more than 3,000 members split evenly between pensioner and deferred members.
Harris said: “If you look at the movement of any UK final salary pension deficit in the last 12 months it will have moved significantly. The movement is very much about the interest rate environment and yields… at an all time low.”
Richard Gibson, associate at Barnett Waddingham, said the gap between RPI and CPI is currently estimated to be between 0.8 and 1.1 per cent a year and could potentially reduce employer contributions by a fifth.
“You might see it reducing the rate of contributions by around 15 per cent, possibly as much as 20 per cent,” said Gibson.
He said trustees face a very difficult decision where scheme rules allow free choice over the index of benefits in payment and need to take into account both the strength of the employer covenant and the funding position of the scheme.
Where schemes are poorly funded, Gibson added, for trustees to continue to provide RPI increases would “effectively be using limited funds to provide a discretionary benefit for pensioner members".
Buyout pricing
Employers and trustees should also consider the impact of a switch to CPI on the value of the scheme’s ultimate buyout premium.
Ben Stone, senior manager at consultancy PwC, said that while the funding impact of a switch to CPI could be a reduction of around 20 per cent in liabilities, the impact on the ultimate buyout premium would be much less.
“When they price CPI benefits, insurers don’t allow for [the] same size of difference in their pricing as a scheme actuary would do when he sets his funding assumptions,” said Stone.
